Question

# An investor wants to earn a 10% return on a stock she buys for \$50 today....

An investor wants to earn a 10% return on a stock she buys for \$50 today. The stock just paid a dividend of \$1.00 per share. What must be the annual growth rate in the dividend if she is using the dividend discount model to price this stock? 10 points

BAII PLUS

Price today P0 = \$50

last dividend, D0 = \$1

required rate of return on stock r = 10%

Using dividend discount model, price can be calculated as

P0 = D0*(1+g)/(r-g)

So here, 50 = 1*(1+g)/(0.1 - g)

=> 50*(0.1-g) = 1+g

=> 5 - 50g = 1 + g

=> g = 4/51 = 7.84%

So, annual growth rate in dividend is 7.84%

Dividend discount model has a formula that can directly be used, so only calculations needs to be computed on a calculator. So, this can even be solved without a BAII calculator.

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